“What comes next?” sings King George III in Lin-Manuel Miranda’s Tony-award winning Broadway smash Hamilton.
Miranda certainly didn’t have Finance Minister Bill Morneau in mind when he composed that song in which the king, after the end of the American Revolutionary War, asks his former colonists, “Do you have a clue what happens now?”
Many Canadians are likely asking the same questions now that the consultation period on the private corporation tax proposals has ended. During the 75-day consultation period, the government received over 21,000 submissions. To put this in perspective, it would take a full-time staffer at the Department of Finance, spending a mere ten minutes reviewing each submission (and many of them are 50 pages or more!), 465 workdays to get through them all.
Since Oct. 2, the formal end of the consultation period, I’ve received copies of numerous submissions from both large and small associations, along with some from private individuals. While the government is reviewing three small business tax proposals, among them income sprinkling and conversion of dividends to capital gains, much of the commentary in the submissions I’ve reviewed is devoted to the government’s intention to tax corporately-earned passive investment income at high combined effective tax rates (73 per cent in Ontario), effectively acting as a deterrent to retaining income in a corporation.
Although no formal effective date or definitive approach for the taxation of passive investment income has been announced, the government said that it “will be designing new rules over the coming months to tax corporate passive income in a way that is more fair for Canadians.” The government invited Canadians to “share views on any aspect of these new rules that you feel are important to bring to the Government’s attention.”
Likely one of the longest, most detailed and thorough submissions, made in three parts and totalling about 150 pages, came from the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada. The Joint Committee brings together members of Canada’s legal and tax communities to periodically evaluate and offer the federal government input on tax laws.
In its submission on the proposed passive investment income proposals, the Joint Committee points out that there are important non-tax reasons for carrying on business activities through a corporation: the corporate form limits the business owner’s liability, thereby encouraging risk-taking and facilitates the raising of capital. In fact, longstanding tax policy in Canada has been to reinforce the incentive to conduct business activities through corporations by having a substantially lower corporate tax than the top personal tax rate. Many other jurisdictions have low corporate tax rates relative to the top marginal personal rates and nonetheless do not appear to tax passive income at high rates (as Canada does) or generally have legislation that penalizes a business for leaving funds in a corporation for investment.
If truth be told, the submission points out, our Canadian tax system is actually currently “under-integrated,” meaning that there is no meaningful tax advantage to earning business income through a corporation if that income is taxed at the general corporate tax rate. In fact, in nine of ten provinces, both corporate income subject to the general corporate tax rate and investment income earned by a private corporation are subject to higher tax rates than would otherwise apply to such income were it earned by an individual.
And, while the Joint Committee concedes that the investment of income eligible for the small business rate is, in some (but not all) provinces taxed at a lower rate, thereby providing an advantage, “that advantage is not significant, and the entire system should not be upended merely to address potential anomalies that arise when corporate income is taxed at the small business rate.”
Meanwhile, a new report out last week from the C.D. Howe Institute claims that Ottawa’s proposed changes for the tax treatment of income from passive investments in incorporated businesses “will not achieve its goal of promoting fairness in the tax system.” The report, entitled “Off Target: Assessing the Fairness of Ottawa’s Proposed Tax Reforms for “Passive” Investments in CCPCs,” was authored by Alexandre Laurin, who assesses the proposals from a fairness perspective and finds them lacking.
“As laid out, these proposals risk delivering a blow to the retirement planning of many small business owners, not to mention their potential negative impacts on entrepreneurship and risk taking,” concludes Laurin.
Specifically, the proposed regime would end the refundable part of the passive investment income tax for CCPCs who earn active business income in their corporations. As a result, private corporations (and their owners) would be taxed on their passive investment income on the same basis as if they were individual investors in fully taxable accounts. “There would be diminished incentives to defer business consumption, and less income and business saving available for spending on capital equipment,” says Laurin. “The same is true of small business income retained for personal purposes — there will be greater incentives for immediate personal consumption of business income rather than saving it for retirement or other purposes.”
In his report, Laurin shows that CCPC income taxed at the general corporate tax rate and reinvested passively in the corporation enjoys no significant tax advantages over other saving options and that business owners earning income taxed at the small-business tax rate and saving it in the corporation for future personal consumption enjoy a tax treatment pretty much on par with others saving through an RRSP or a TFSA.
“Considering that additional administration, accounting, and tax compliance costs need to be incurred in corporate accounts, one could reasonably conclude that passively reinvested small-business earnings receive a tax treatment similar to that of RRSP/TFSAs in a variety of possible portfolio compositions,” says Laurin.
Laurin feels that if the government were to proceed with changes to tax passive income retained in CCPCs along the lines it has outlined, “it should level the playing field so business owners have tax-assisted retirement saving opportunities comparable to those available to most public-sector employees in (defined benefit) plans and Members of Parliament.”